A Proposal for the Resolution of Systemically Important Assets and ...
A Proposal for the Resolution of Systemically Important Assets and ...
A Proposal for the Resolution of Systemically Important Assets and ...
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guidelines in repo market financing (<strong>and</strong> similarly in o<strong>the</strong>r SIALs), <strong>the</strong>y would effectively be<br />
subjecttosolvencycriteriasimilartothose<strong>for</strong>banks(<strong>and</strong>mightnotsurvivecompetitionfrom<br />
banksin<strong>the</strong>firstplace).Fur<strong>the</strong>r,while<strong>the</strong>primaryriskcontrolinGortonMetrickschemeis<br />
through restriction <strong>of</strong> eligible collateral <strong>for</strong> safe harbor provisions, safe harbor is in principle<br />
eliminatedfromourreporesolutionauthority<strong>and</strong>itjustconditionallyhappenstobeakinto<br />
safeharborinsomecaseseven<strong>for</strong>eligiblecollateral(whendefaultsareisolatedasin6)above).<br />
Our proposal also has some similarities to <strong>the</strong> Federal Liquidity Options proposal <strong>of</strong><br />
Tuckman (2012b) which recommends that central banks presell liquidity options as <strong>the</strong><br />
exclusivemeans<strong>of</strong>lendingmoneytononbankinginstitutionsinacrisis.Theidea<strong>of</strong>reducing<br />
<strong>the</strong>risk<strong>of</strong><strong>the</strong>lender<strong>of</strong>lastresortthroughpaid<strong>for</strong>commitments,<strong>and</strong><strong>the</strong>rebyminimizing<strong>the</strong><br />
expostsocialization<strong>of</strong>residualrisks,isinsimilarspiritasourproposal.Thedifferenceisthat<br />
ourapproachalsoproposesamechanismtomanage<strong>the</strong>residualrisksnotbackedby<strong>the</strong>lender<br />
<strong>of</strong>lastresort(or<strong>the</strong>reporesolutionauthority)once<strong>the</strong>exantecommitmentshavebeenmet<br />
(paymentsbeyondconservativehaircutsaremadewithimmediacy).<br />
Finally,Bliss<strong>and</strong>Kaufman(2011)proposerefinements<strong>of</strong><strong>the</strong>OLAunder<strong>the</strong>DoddFrank<br />
Actthatwouldapplyregularbankruptcyproceedingst<strong>of</strong>ailingfinancialfirmsbutwithadvance<br />
payments to such firms upon failure (“modified debtorinpossession (DIP) financing”) <strong>and</strong><br />
m<strong>and</strong>atorybutlimitedhaircutstoall“protected”(e.g.,safeharbored)creditors.Both<strong>of</strong><strong>the</strong>se<br />
refinements also feature in our proposal, as immediate liquidity provided by <strong>the</strong> repo<br />
resolutionauthoritytoclaimsinfailure<strong>and</strong><strong>the</strong>creditriskonunderlyingcollateralbeingpassed<br />
onto<strong>the</strong>claimsinduecourse.Thekeydistinguishingfeature<strong>of</strong>ourproposalisthatitgrants<br />
<strong>the</strong>rightstolargescaleassetliquidationsto<strong>the</strong>resolutionauthorityinordertoaddress<strong>the</strong><br />
issue<strong>of</strong>disorderlybankruptcyorfiresaleswhen<strong>the</strong>failure<strong>of</strong>aninstitutionisnotinisolation<br />
butiscoincidentwitho<strong>the</strong>rregulations.<br />
Itisimportanttodiscusswhatwouldhappentorepocontractsoncollateralthatisnot<br />
eligible under <strong>the</strong> repo resolution authority <strong>and</strong> its strict guidelines <strong>and</strong> requirements. This<br />
wouldconstitute<strong>the</strong>hypo<strong>the</strong>tical“shadowbanking”inaworld<strong>of</strong>reporesolutionauthorities.<br />
Theserepocontractswouldnothaveaccesstosafeharbor<strong>and</strong>wouldbeperceivedasexante<br />
riskier<strong>and</strong><strong>of</strong>lowerliquiditybyfinanciers.However,thiswouldnotnecessarilyguaranteethat<br />
financiersinternalize<strong>the</strong>externalities<strong>of</strong>runsin<strong>the</strong>shadowbanking.Toguardagainstthis,<strong>the</strong><br />
reporesolutionauthorityshouldonaperiodicbasisassessifaclass<strong>of</strong>repoclaimshasbecome<br />
large enough <strong>and</strong> <strong>the</strong> underlying collateral is suitable quality enough to be eligible <strong>for</strong> repo<br />
resolutionauthority’sLOLR.Ifyes,<strong>the</strong>yshouldberequiredbylegislationtobemovedout<strong>of</strong><br />
shadowbankinginto<strong>the</strong>reporesolutionauthority.And,where<strong>the</strong>underlyingcollateralisnot<br />
<strong>of</strong> adequate quality or repo contract class sufficiently small in size, a minimum haircut (or<br />
overcollateralization) requirement should be imposed, akin to FDIC’s proposed haircut on all<br />
reposoramorerisksensitiveschemesuchasbankcapitalrequirements.Ideally,<strong>the</strong>haircut<br />
schemeshouldbecountercyclical<strong>and</strong>certainlynotprocyclical(thatis,notprovidetoolowor<br />
nonexistenthaircutsingoodtimes,suchasonMBSwithlowqualitymortgagesorgovernment<br />
bondreposwheregovernmentcreditriskisnontrivialasin<strong>the</strong>Eurozonesince2008).<br />
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